Is Your Business Strapped for Cash?

Cash is the life line of your business. Understanding your business’ cash cycle can help you prepare for periods of high growth and declining revenues. As a business owner, it is important to understand the impact of cash on a daily basis. At times, one might assume banks simply lend money to provide cash flow and working capital; however with today’s technology banks have a plethora of cash management solutions to optimize cash flow by shortening the cash conversion cycle.

Let us first look at cash flow and the cash conversion cycle (CCC). Cash flow is not simply determined by looking at the bottom line of your profit and loss statement to see if your business is in the “black” or the “red”. It is determined by the timing of your accounts receivables (A/R), inventory, accounts payable (A/P), capital expenditures, borrowings and debit services. The CCC is the number of days your cash remains tied up in the operations of your business. The formula below can help you calculate your CCC:

* CCC = IOD + AROAPO

It is extremely common for a company to be profitable, but to simultaneously be short on cash if the accounts receivable have not been collected or there is a large inventory build-up. The more quickly the A/R are collected and inventory is sold, the shorter the CCC and higher the cash balance.

Even if your business is showing a profit, if the cash flow is not under control, you could be strapped for cash.

If inventory builds up, then cash is tied up in products that have not been sold.  This may cause a business to slash prices in an effort to move product. Consequently, the business reduces its profit margins to gain needed cash. If there is difficulty in collecting payments (essentially an interest free loan to your customer), cash is not available to reinvest in the business or pay down a loan. For instance, by using the formula above, you can compute that a company with $5MM in revenue, a cost of goods sold of $3MM, an A/R of $500m, an A/P of $456m and an inventory of $411m has a CCC of 31 days. If the company were to collect its accounts receivable one day sooner and stretch its accounts payable one day longer, an additional $30m would be made available to reinvest in the business. 

The timing of the cash conversion cycle is essential. As noted above, a day or two lag in collecting payments can significantly improve business operations. Solutions including remote image capture, express deposit, ACH, merchant services, wires and online banking can help your business improve its CCC. To illustrate, Remote Image Capture extends the deposit deadline from 2pm to 5:30pm and ACH capabilities eliminate mail delays and check clearing time frames making cash available sooner and reducing your risk of fraud. If you are not fully utilizing, or are unaware of the range of services your bank has to offer, it is worth investing the time to understand what may be beneficial to your business.

If you have any questions regarding your business’ unique treasury management needs, or would like to know more about cash management solutions, please contact Jennifer Roths at 312-4925-111, Chris Prestegaard at 847-956-3944, or Michael Moran at 847-418-3226 with American Chartered Bank, a strategic partner with the Chicago Family Business Council.

* IOD – (Inventory / COGS X # of days in period). It measures the length of time on average between acquisition and sale of merchandise.

ARO – (Accounts Receivable / Sales X # of days in period). It measures the average number of days from the sale of goods to collection   of resulting receivables.

APO – (Account Payable / COGS X # of days in period). It measures the average length of time between purchase of goods and payment for them.

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